2018-03-02

Everyone Loses From War War Too

One of the most trite sayings about a trade war is that everyone loses. Which is true in the sense that everyone is usually worse off economically if you measure purely in terms of GDP and you look only at the immediate impact on the economy, and not long-term structural reform. Similar to the way if you look at a war, everyone loses soldiers, destroys tanks, missiles, planes and other hardware and disrupts their national economies. But if country A takes over country B, or country B's military is so degraded that it no longer poses a military threat, then something was won.

In the same way, if you look beyond pure GDP measures, countries can win trade wars. Deficit countries and surplus countries experience different effects from a trade war. The deficit country gets inflation and a relative increase in employment and production. The surplus country gets deflation and a decrease in employment and production. If country A is the dynamic economy and can quickly fire workers and build new industries, it will reform itself rather quickly. If country B is centrally planned or cannot fire workers easily, and cannot reform rapidly, it will be mired in recession for much longer.

I expect carveouts for Europe, but if there's an all out trade war, the Eurozone already has 9% unemployment. Who is going to win election if European unemployment rises to 15 or 20 percent? Europe will move in a nationalist direction. The establishment doesn't have the political capital to fight a trade war, they spent it all on bringing in migrants and already have a deficit.

The ultimate containment strategy for the U.S. and regional partners (who all have access to U.S. markets) then, is an economic strategy. Yes, these nations will suffer slower growth, but they will retain their sovereignty. For East Asian nations, a distant hegemon is better than the near one with an appetite for your territory.

Whichever path is chosen, the economic and geostrategic paths will line up. An economic crisis in China will add the economic component to the emerging geostrategic China policy. A geostrategic decision to confront China economically would set in motion an economic crisis that would propel the strategy forward since China would respond in kind. The decision to halt rare earth exports to Japan and the widespread anti-Japanese riots of recent years already show how China will respond. A major confrontation from the U.S. would require an even larger policy response. Luttwak lays out some possible policy choices, starting with small ones such as banning technology transfers in a limited area such a military or telecom. I fully expect that were a Chinese crisis and devaluation to accompany another recession in the United States, the push for tariffs would find a bipartisan majority in the House and Senate.

Politics is zero sum. If issues of sovereignty, security and power outweigh concern for GDP, trade wars make more sense than kinetic wars. If the U.S. wants to push China out of the South China Sea, it is better to try with a trade war than a total war that includes a complete halt in trade.